Fed researchers warn oil price rise could lift core inflation to 2.8% by mid 2027
A group of Federal Reserve researchers has reported that oil price increases now have a greater and more persistent effect on core inflation in advanced economies compared to the period before the COVID-19 pandemic. Based on recent models, if current trends continue, average core inflation across five major economies could approach 2.8% by the middle of 2027.
Study tracks shifting inflation dynamics
The study, prepared by Andrea De Michelis, Musa Orak, Avani Pradhan, and Albert Queralto, analyzed economic data from 2000 through the second quarter of 2026 for the United States, Canada, the Eurozone, Japan, and the United Kingdom. The researchers examined how changes in Brent crude oil prices influence core inflation, a preferred measure for underlying price trends, while also factoring in supply chain disruptions and shifts in economic activity.
Between 2000 and the onset of the pandemic, the link between oil prices and core inflation was found to be weak. However, from the start of 2021, this relationship became both statistically significant and more pronounced. The measure reflecting how much inflation from one quarter carries into the next rose from 0.35 to 0.65 during this period.
Impact of a 10% oil price increase
To demonstrate the magnitude of this shift, the researchers modeled a scenario in which oil prices rise permanently by 10%.
They found that under pre-pandemic conditions, the cumulative effect on the price index used to calculate core inflation would be approximately 0.05% after three years. Under post-pandemic dynamics, the increase would reach about 0.35% over the same timeframe, with most of the impact emerging within the first two years.
The updated analysis signals that oil shocks may have a stronger and more persistent role in shaping inflation, especially as supply chain pressures and demand shifts linger in global economies.
Projected core inflation and policy implications
For their 2027 projection, the team based calculations on Brent crude futures prices from early August 2026 and assumed that supply chain pressures would gradually ease. Using pre-pandemic relationships, annual average core inflation would peak near 2.2%. When accounting for greater inflation persistence, this rate rises to about 2.5%. If the amplified effect of oil prices is also considered, core inflation could reach nearly 2.8% by mid 2027 before dropping back toward 2.2% by the end of 2028.
The researchers view this 2.8% scenario as an upper boundary for potential outcomes, given that it relies on both persistent post-pandemic inflation and sustained oil price impacts. They also note that disentangling one-off oil shocks from deeper behavioral changes in business pricing, as well as from prolonged supply disruptions, remains challenging.
Investors and market observers are watching these developments closely, especially as central banks weigh monetary responses to sustained inflationary pressures from energy markets.
Central bank response and asset market effects
The study also models a scenario where a 10% oil price jump is caused by a supply disruption. When higher oil costs feed more directly into core inflation and inflation remains persistent, the resulting hit to economic activity nearly doubles compared to pre-pandemic conditions.
In such a setting, central banks may tighten monetary policy more aggressively, increasing interest rates even as economic growth slows. This dynamic can suppress production by pushing up costs, while higher borrowing costs in turn restrain consumer spending.
The European Central Bank and the Bank of England are reportedly observing stable trends in core inflation indicators, but they also highlight heightened upward risks. According to the Fed researchers, if oil prices remain elevated for longer than futures markets currently project or if supply disruptions persist, these factors could increase the risk of higher core inflation.
In a prolonged high-inflation environment, central banks may keep interest rates elevated for longer. This could make yields on short-term government debt more attractive and reduce investors’ appetite for risk. As a result, demand for Bitcoin and other cryptocurrencies may weaken, leaving prices under downward pressure.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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